Earnings inequality and earnings mobility: New evidence from OECD nations

Andrea Garnero, Alexander Hijzen, Sébastien Martin21 March 2016

Some economists argue that income inequality suggests intra-generational mobility in society. This column provides comprehensive evidence across a large number of advanced economies on the importance of intra-generational mobility and its relationship with earnings inequality. The findings do not support the belief that higher earnings inequality necessarily goes hand-in-hand with greater mobility over the working life. Higher inequalities are not systematically compensated by higher mobility opportunities.

In many countries, in particular in the US, the perception that inequality has deepened and upward mobility has stalled has become a prominent topic in the political debate (Putnam 2015). While in the past, again especially in the US, inequality was seen by some as the price to pay for upward mobility, this view has become less common as mobility does not appear to have risen in tandem with rising inequality.

Understanding the relationship between inequality and mobility is important for at least two reasons. First, it is crucial for understanding the depth of economic inequalities:

“Consider two societies that have the same annual distribution of income. In one there is great mobility and change so that the position of particular families in the income hierarchy varies widely from year to year. In the other, there is great rigidity so that each family stays in the same position year after year. The one kind of inequality is a sign of dynamic change, social mobility, equality of opportunity; the other, of a status society” (Friedman 1962).

Second, perceptions of mobility play an important role in shaping attitudes to inequality and redistribution and hence preferences for public policies. Alexis De Tocqueville first proposed in Democracy in America the idea that the difference in attitudes towards redistribution between Europe and the US can be explained by differences in mobility rates (De Tocqueville 1835).

A still common line of argument is that inequality is the price to pay for a labour market that offers everyone opportunities commensurate with their talent and effort. This argument suggests that a positive relationship should hold between inequality and mobility, whether mobility is measured between generations (inter-generational mobility) or over the course of one’s working life (intra-generational mobility). However, neither in the context of inter-generational mobility nor in that of intra-generational mobility has this belief been grounded in firm empirical evidence. Indeed, Alan Krueger, in a speech as the Chairman of the Council of Economic Advisors, showed that the relationship between inequality and mobility between generations is negative rather than positive (Krueger 2012). This led him to dub this relationship the ‘Great Gatsby curve’, in an ironic reference to the character who rises ‘from the rags to riches’ in F Scott Fitzgerald's classic novel. The existing empirical studies on the relationship between inequality and intra-generational mobility have yielded mixed results at best, but these studies have been limited to the US and one or a few European countries and thus may not tell the full story.

In new research, we provide for the first time comprehensive evidence across a large number of advanced economies on the importance of intra-generational mobility and its relationship with earnings inequality (Garnero et al. 2016). It does so by adapting and extending the simulation methodology proposed by Bowlus and Robin (2012) to generate individual earnings and employment trajectories in the longer term using short panel data for 24 OECD countries. A validation exercise using social security data for Italy shows that this approach captures the observed evolution of earnings and, particularly, the degree of mobility rather well. Our analysis provides a number of important insights:

First, on average across the countries analysed, mobility (i.e. movements up and down the wage ladder and in and out employment) reduces inequality, as measured by the Gini index, by about 25% over the first 20 years of careers (see Figure 1).

Since the bulk of mobility occurs during the first 15 years of one’s career, this implies that approximately 75% of inequality within a year is permanent.

Figure 1. The equalising effect of mobility

Source: Author’s calculations based on the European Union Statistics on Income and Living Conditions (EU-SILC) for European countries and Turkey, Household, Income and Labour Dynamics (HILDA) for Australia, German Socio-Economic Panel (GSOEP) for Germany, Keio Household Panel Survey (KHPS) for Japan, Korean Labor and Income Panel Study (KLIPS) for Korea, Swiss Household Panel (SHP) for Switzerland and Survey of Income and Program Participation (SIPP) for the United States.

Second, the cross-country correlation between mobility and inequality at a point in time tends to be weak and depends on the measure of inequality used (see Figure 2).

This means that the belief that higher inequality is compensated by higher mobility is not validated – only when using inequality indices focusing on the tails of the distribution (for example, the P90/P10 and P50/P10 percentile ratios) the relationship between inequality and mobility is strongly significant and positive while this is not the case when using indices considering the entire distribution (for instance, the Gini index).

Figure 2. Correlation between mobility and inequality, active persons

Source: Author’s calculations based on the European Union Statistics on Income and Living Conditions (EU-SILC) for European countries and Turkey, Household, Income and Labour Dynamics (HILDA) for Australia, German Socio-Economic Panel (GSOEP) for Germany, Keio Household Panel Survey (KHPS) for Japan, Korean Labor and Income Panel Study (KLIPS) for Korea, Swiss Household Panel (SHP) for Switzerland and Survey of Income and Program Participation (SIPP) for the US.

Third, when looking at the relationship between mobility and inequality along the entire earnings distribution, we find that any positive relationship between inequality and mobility is driven by the relationship between inequality in the bottom of the distribution (Figure 3, Panel A).

Moreover, the positive correlation between earnings mobility and short-term inequality across countries disappears when considering only individual who are continuously employed (Figure, Panel B). This suggests that the positive relationship between mobility and inequality in the bottom of the distribution is driven by movements between employment and unemployment and not mobility up and down the earnings ladder.

Figure 3. The correlation between inequality and mobility along the distribution

Source: Author’s calculations based on the European Union Statistics on Income and Living Conditions (EU-SILC) for European countries and Turkey, Household, Income and Labour Dynamics (HILDA) for Australia, German Socio-Economic Panel (GSOEP) for Germany, Keio Household Panel Survey (KHPS) for Japan, Korean Labor and Income Panel Study (KLIPS) for Korea, Swiss Household Panel (SHP) for Switzerland and Survey of Income and Program Participation (SIPP) for the United States.

In conclusion, our findings do not support the belief that higher earnings inequality goes necessarily hand-in-hand with greater mobility over the working life. Higher inequalities are not systematically compensated by higher mobility opportunities. There is no negative correlation as in the context of inequality and mobility across generations, but neither a positive relationship as many, especially in the Anglo-Saxon world, appear to believe. This means that policies and institutions can yield different combinations of inequality and mobility.

The positive relationship between inequality in the bottom of the distribution and employment mobility (movements in and out of employment) most likely reflects the role of policies and institutions for wage compression in the bottom of the distribution and employment mobility. Policies and institutions such as unemployment benefits, statutory minimum wages and collective wage agreements effectively impose wage floors and, as a result, have a tendency to lead to a more compressed wage distribution. In doing so, these institutions also make it harder for individuals to escape unemployment and hence reduce employment mobility. In countries where such institutions are weak, unemployed workers may find jobs more easily but these jobs tend to be less well paid and less secure since due to the weaker bargaining position of unemployed persons.

Editors' note: The views expressed in this column are those of the authors and cannot be attributed to the institutions they work for and their member states.

References

Bowlus, A and J-M Robin (2012), “An International Comparison Of Lifetime Inequality: How Continental Europe Resembles North America”, Journal of the European Economic Association 10(6): 1236-1262.